Ben Bernanke's Brilliant Strategy

The topic is the labor market, and the basic gist seems to be
that Bernanke doesn't fully buy the jobs recovery yet.

People are wondering whether Bernanke is once again behind the
curve, missing a broader recovery, and proving he's a poor
forecaster. There is some basis to this in the fact that the
Fed's employment projections have been behind the curve.

But we think he's playing it smart. He wants people to think the
Fed is behind the curve. This is how you establish that the Fed
will stay on hold for a long time, even if inflation picks up. If
Bernanke comes off as too much of a realist, people will think
that he'll hike rates as soon as possible.

This is pretty well played.

Here's the full speech

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Recent Developments in the Labor Market

My remarks today will focus on recent and prospective
developments in the labor market. We have seen some
positive signs on the jobs front recently, including a pickup in
monthly payroll gains and a notable decline in the unemployment
rate. That is good news. At the same time, some key
questions are unresolved. For example, the better jobs
numbers seem somewhat out of sync with the overall pace of
economic expansion. What explains this apparent discrepancy
and what implications does it have for the future course of the
labor market and the economy?

Importantly, despite the recent improvement, the job market
remains far from normal; for example, the number of people
working and total hours worked are still significantly below
pre-crisis peaks, while the unemployment rate remains well above
what most economists judge to be its long-run sustainable
level. Of particular concern is the large number of people
who have been unemployed for more than six months.
Long-term unemployment is particularly costly to those directly
affected, of course. But in addition, because of its
negative effects on workers' skills and attachment to the labor
force, long-term unemployment may ultimately reduce the
productive capacity of our economy. The debate about how
best to address long-term unemployment raises another important
question: Is the current high level of long-term
unemployment primarily the result of cyclical factors, such as
insufficient aggregate demand, or of structural changes, such as
a worsening mismatch between workers' skills and employers'
requirements? If cyclical factors predominate, then
policies that support a broader economic recovery should be
effective in addressing long-term unemployment as well; if the
causes are structural, then other policy tools will be
needed. I will argue today that, while both cyclical and
structural forces have doubtless contributed to the increase in
long-term unemployment, the continued weakness in aggregate
demand is likely the predominant factor. Consequently, the
Federal Reserve's accommodative monetary policies, by providing
support for demand and for the recovery, should help, over time,
to reduce long-term unemployment as well.

Recent Labor Market Developments
As background for my discussion, let me provide a brief review of
recent job market indicators. As this audience is well
aware, job creation has picked up recently. Private payroll
employment (figure 1) increased by nearly
250,000 jobs per month, on average, in the three months ending in
February, and by about 190,000 jobs per month, on average, over
the past 12 months. At the same time, layoffs in the
public sector appear to be moderating. Together with a
lengthening of the average workweek, these employment gains have
contributed to a significant increase in aggregate hours worked
(figure 2).

The increase in hours worked is encouraging, because the decline
in hours during the recent recession was extraordinary.
From the peak of this series in December 2007 to its trough in
February 2010, aggregate hours on the job by production workers
fell by a remarkable 9-1/2 percent; by comparison,
production-worker hours declined by "only" 5-3/4 percent
during the severe 1981-82 recession. Currently, hours
worked are still about 4 percent below the pre-recession peak--a
clear improvement from where we were two years ago, but still far
from where we would like to be.

The government estimates payroll employment--the number of
jobs--from a survey of businesses--the establishment
survey. A monthly survey of about 60,000 households, which
provides the data needed to construct the national unemployment
rate, offers an alternative estimate of the number of jobs.
Employment as estimated from the household survey, adjusted
to correspond as closely as possible to the concept of employment
measured in the establishment survey (figure 3), also shows an
improvement in the labor market--indeed, by somewhat more than in
the establishment survey. I should note, however, that
month-to-month changes in this measure are much more volatile
than the employment measure from the establishment survey, which
is why the Federal Reserve puts more weight on the establishment
survey for the purposes of short-term forecasting.

The positive signs from the labor market have shown through to
measures of labor utilization: After hovering around 9
percent for much of last year, the unemployment rate (figure 4) has moved down since
September to 8.3 percent in February, and the share of employment
represented by people working part time for economic reasons, an
indicator of underutilization, has declined modestly.

Surveys of households and firms about their attitudes and
expectations offer yet another window on job market
developments. Since the summer, household expectations for
labor market conditions over the next year have gotten brighter
(figure 5), unwinding a
deterioration registered earlier last year. Business hiring
plans have also shown modest gains (figure 6). Other
indicators, such as new claims for unemployment insurance and
measures of the breadth of hiring across industries, also point
to better labor market conditions.

Notwithstanding these welcome recent signs, the job market
remains quite weak relative to historical norms, as I've already
noted. After nearly two years of job gains, private payroll
employment remains more than 5 million jobs below its previous
peak; the jobs shortfall is even larger, of course, when
increases in the size of the labor force are taken into
account. And the unemployment rate in February was still
roughly 3 percentage points above its average over the 20 years
preceding the recession. Moreover, a significant portion of
the improvement in the labor market has reflected a decline in
layoffs rather than an increase in hiring.

This last observation is illustrated by the data on gross job
flows (figure 7). The monthly
increase in payroll employment, which commands so much public
attention, is a net change. It equals the number of hires
during the month less the number of separations (including
layoffs, quits, and other separations). In any given month,
a large number of workers are being hired or are leaving their
current jobs, illustrating the dynamism of the U.S. labor
market. For example, between 2001 and 2007, private
employers hired nearly 5 million people, on average, each
month. Total separations, on average, were only slightly
smaller. Taking the difference between gross hires and
separations, the net monthly change in payrolls during this
period was, on average, less than 100,000 jobs per month--a small
figure compared to the gross flows.

The recent history of these flows suggests that further
improvement in the labor market will likely need to come from a
shift to a more robust pace of hiring. As figure 7 shows,
the declines in aggregate payrolls during the recession stemmed
from both a reduction in hiring and a large increase in
layoffs. In contrast, the increase in employment since the
end of 2009 has been due to a significant decline in layoffs but
only a moderate improvement in hiring. To achieve a more
rapid recovery in the job market, hiring rates will need to
return to more normal levels.

The Change in Unemployment and Economic Growth: A
Puzzle?
What will lead to more hiring and, consequently, further declines
in unemployment? The short answer is more-rapid economic
growth. Indeed, the improvement in the labor market
over the past year--especially the decline in the unemployment
rate--has been faster than might have been expected, given that
the economy during that time appears to have grown at a
relatively modest pace. About 50 years ago, the
economist and presidential adviser Arthur Okun identified a rule
of thumb that has come to be known as Okun's law. That rule
of thumb describes the observed relationship between changes in
the unemployment rate and the growth rate of real gross domestic
product (GDP). Okun noted that, because of ongoing
increases in the size of the labor force and in the level of
productivity, real GDP growth close to the rate of growth of its
potential is normally required just to hold the unemployment rate
steady. To reduce the unemployment rate,
therefore, the economy must grow at a pace above its
potential. More specifically, according to currently
accepted versions of Okun's law, to achieve a 1 percentage
point decline in the unemployment rate in the course of a year,
real GDP must grow approximately 2 percentage points faster than
the rate of growth of potential GDP over that period. So,
for illustration, if the potential rate of GDP growth is 2
percent, Okun's law says that GDP must grow at about a 4 percent
rate for one year to achieve a 1 percentage point reduction in
the rate of unemployment.

In light of this historical regularity, the combination of
relatively modest GDP growth with the more substantial
improvement in the labor market over the past year is something
of a puzzle. Resolving this puzzle could give us important
insight into how the economy is likely to evolve. To
illustrate the tension, consider the relationship between the
recent changes in the unemployment rate and in real GDP relative
to the predictions of Okun's law (figure 8). As illustrated
by the position of the square labeled "2011" relative to the
Okun's law relationship, represented by the line, the decline in
the unemployment rate over the course of 2011 was greater than
would seem consistent with GDP growth over that period.
Indeed, with last year's real GDP growth below 2 percent, less
than what most economists would estimate to be the U.S. economy's
potential rate of growth, one might have expected little change
in the unemployment rate last year or even a slight
increase. What is this confluence of the significant
decline in the unemployment rate and the modest recent increase
in real GDP telling us about the state of the economy, and how
will the Okun's law puzzle be resolved?

The apparent failure of Okun's law could reflect, in part,
statistical noise. For example, it may be that future data
revisions will show that real GDP grew more quickly over the past
year than currently estimated. However, although it is
certainly possible that revised data will ultimately explain part
of the puzzle, at this point we have no specific evidence
suggesting that such a revision might be in the offing. For
example, gross domestic income, an alternative measure of
economic activity constructed using source data that are mostly
different from the data used in estimating GDP, provides some
check on the information provided by the better-known GDP
measure. However, gross domestic income is currently
estimated to have increased less quickly than GDP in
2011 and so does not point to an explanation of the drop in the
unemployment rate.

Another logical possibility is that the decline in the
unemployment rate could be overstating the improvement in the job
market. For example, potential workers could be giving up
on looking for work to an unusual extent. Because a person
has to be either working or looking for work to be counted as
part of the labor force, an increase in the number of people too
discouraged to continue their search for work would reduce the
unemployment rate, all else being equal--but not for a positive
reason. A story centered on potential workers dropping out
of the labor force might seem in line with the low level of the
labor force participation rate (figure 9). But other data
cast doubt on that idea. For example, a broad measure of
labor underutilization that includes people only marginally
attached to the labor force has declined about in line with the
unemployment rate since late 2010 (figure 10).1
On balance, an assessment of a broad range of indicators
suggests that a substantial portion of the decline in the
unemployment rate does reflect genuine improvement in labor
market conditions.

Yet another interpretation of the recent improvement is that it
represents a catch-up from outsized job losses during and just
after the recession. In 2008 and 2009, the decline in
payrolls and the associated jump in unemployment were
extraordinary. In particular, using the Okun's law metric,
the run-up in the unemployment rate in 2009 appears "too large"
relative even to the substantial decline in real GDP that
occurred. This point can be seen by returning to figure 8,
which shows the Okun's law relationship. The open triangle
labeled "2009" in the upper left of the figure shows an increase
in the unemployment rate in that year well above the one implied
by the contraction in real GDP and Okun's law. In other
words, employers reduced their workforces at an unusually rapid
rate near the business cycle trough--perhaps because they feared
an even more severe contraction to come or, with credit
availability sharply curtailed, they were trying to conserve
available cash.

The diagram suggests that what we may be seeing now is the flip
side of the fear-driven layoffs that occurred during the worst
part of the recession, as firms have become sufficiently
confident to move their workforces into closer alignment with the
expected demand for their products. Such a dynamic would
explain the position of the square labeled "2011" in that figure
being far below the line representing Okun's law. Of
course, Okun's law is a noisy relationship, and we don't really
know if the better-than-expected labor market performance of 2011
has largely offset the worse-than-expected performance in
2009. However, to the extent that the decline in the
unemployment rate since last summer has brought unemployment back
more into line with the level of aggregate demand, then further
significant improvements in unemployment will likely require
faster economic growth than we experienced during the past year.
It will be especially important to evaluate incoming
information to assess whether the recovery is picking up as
improvements in the labor market feed through to consumer and
business confidence; or, conversely, whether the headwinds that
have impeded the recovery to date continue to restrain the pace
at which the labor market and economic activity normalize.

The Challenge of Long-term Unemployment
Discussions of the labor market at this juncture necessarily have
a "glass half-empty or half-full" tone. Recent improvements
are encouraging, but, as I have noted, in an absolute sense, the
job market is still far from normal by many measures, and
millions of families continue to suffer the day-to-day hardships
associated with not being able to find suitable employment.
Although most spells of unemployment are disruptive or costly,
the persistently high rate of long-term unemployment we have seen
over the past three years or so is especially concerning.
In this episode, both the median and average durations of
unemployment have reached levels far outside the range of
experience since World War II (figure 11). And the share
of unemployment that represents spells lasting more than six
months has been higher than 40 percent since December 2009
(figure 12). By way of
comparison, the share of unemployment that was long term in
nature never exceeded 25 percent or so in the severe 1981-82
recession.

Those who have experienced unemployment know the burdens
that it creates, and a growing academic literature documents some
dimensions of those burdens. For example, research has
shown that workers who lose previously stable jobs experience
sharp declines in earnings that may last for many years, even
after they find new work.2
Surveys indicate that more than one-half of the households
experiencing long unemployment spells since the onset of the
recent recession withdrew money from savings and retirement
accounts to cover expenses, one-half borrowed money from family
and friends, and one-third struggled to meet housing
expenses.3
Unemployment also takes a toll on people's health and may
have long-term consequences for the families of the unemployed as
well. For example, studies suggest that unemployed people
suffer from a higher incidence of stress-related health problems
such as depression, stroke, and heart disease, and they may have
a lower life expectancy.4
The children of the unemployed achieve less in school and
appear to have reduced long-term earnings prospects.5

In addition, unemployment--especially long-term
unemployment--imposes important economic costs on everyone, not
just the unemployed themselves. Elevated unemployment
strains public finances because of both lost tax revenue and the
payment of increased unemployment benefits and other income
support to affected families. People unemployed for a long
time have historically found jobs less easily than those
experiencing shorter spells of unemployment, perhaps because
their skills erode, they lose relationships within the workforce,
or they acquire a stigma that deters firms from hiring
them. Loss of skills and lower rates of employment reduce
the economy's overall productive capacity over the longer term.
In the shorter term, because the process of matching the
long-term unemployed to jobs typically takes more time, the
currently high level of long-term unemployment might in itself be
a reason that further progress in reducing the unemployment rate,
and thus in achieving a more complete recovery, could be
slow.6

A pessimistic view is that a large share of the unemployment we
are seeing, particularly the longer-term unemployment, is
structural in nature, reflecting factors such as inadequate
skills or mismatches between the types of skills that workers
have and the skills that employers demand. If this view is
correct, then high levels of long-term unemployment could persist
for quite a while, even after the economy has more fully
recovered. And it appears true that over the past two
decades or so, structural factors have been responsible for some
increase in long-term unemployment. For example, because an
older worker who loses a job typically takes longer to find a new
job than does a younger worker in the same situation, the aging
of the baby boom generation has probably contributed to a gradual
rise in long-term unemployment. Factors such as
globalization, technological change, and the loss of lower-skill
manufacturing jobs have likely reduced the employability and
earnings potential of some groups of workers. To the extent
that higher rates of unemployment, especially long-term
unemployment, result from structural factors, the scope for
countercyclical policies to reduce unemployment would be
impaired, and the benefits of a more complete economic recovery
for many workers who are unemployed or discouraged would be more
limited.

However, although structural shifts are no doubt important in the
longer term, my reading of the research is that, at most, a
modest portion of the recent sharp increase in long-term
unemployment is due to persistent structural factors.7
Consider, for example, rates of job finding by those
unemployed for varying amounts of time (figure 13).
Unsurprisingly, the rate at which the long-term unemployed find
work is lower than that of those who have been unemployed for
only a short time; on average over the period from 1994 to 2007,
a bit more than one-third of those already unemployed for one to
four weeks found employment within the next month. In
contrast, over that same period, only about one-sixth of those
already unemployed for more than 27 weeks managed to find a job
within a month.

If the recent increase in long-term unemployment were being
driven by structural factors rather than, say, the severity of
the recession, then the job-finding rates of the long-term
unemployed should have fallen sharply relative to those out of
work for only a few weeks. But that's not what we're
seeing. Rather, as figure 13 shows, the job finding rates
of the more recently unemployed and the long-term unemployed all
fell over the recession in roughly the same proportion, and they
remain low.8
This pattern is consistent with cyclical factors
accounting for the bulk of the recent increase in long-term
unemployment. Similarly, the fact that labor demand appears
weak in most industries and locations is suggestive of a general
shortfall of aggregate demand rather a worsening mismatch of
skills and jobs. Counterexamples like the energy boom in
the upper Midwest, where there may be some mismatch in the
geographic location of suitably skilled workers or an overall
shortage of potential workers with relevant skills, might best be
interpreted as the exceptions that prove the rule; a mismatch
story would suggest that strong labor demand would be appearing
in more sectors or geographical areas by now.

An empirical relationship that economists have long used to
interpret developments in the labor market is known as the
Beveridge curve (figure 14). That
curve--named after the British economist William
Beveridge--compares unemployment (the number of workers looking
for employers) to job vacancies (the number of workers that
employers are seeking). In good times, when the
unemployment rate is low, businesses are growing and workers are
harder to find, so job vacancies tend to be high.
Similarly, in bad times, unemployment is high and few jobs are
available (vacancies are low). Thus, the Beveridge curve,
the relationship between unemployment and vacancies, is downward
sloping.

On the usual interpretation, a recession is a period in which the
economy is moving down along the Beveridge curve; as output and
the demand for labor fall, job vacancies decline and unemployment
rises. In contrast, changes in the structural determinants
of unemployment are thought to be reflected in shifts of the
Beveridge curve to the left or right. For example, suppose
that, because of changes in technology or in the mix of
industries and jobs, the mismatch between the skills of the
unemployed and the needs of employers worsens. Then, for a
given number of job openings, the number of the unemployed who
are qualified for those jobs is smaller and the unemployment rate
is higher than it would have been before the mismatch problem
worsened. Graphically, an increase in a skills mismatch
would be reflected in a shift of the Beveridge curve up and to
the right.

From figure 14, we can see some outward shift in the relationship
between job vacancies and unemployment, consistent with some
increase in structural unemployment since the onset of the
recession. However, a more in-depth analysis of the
evidence suggests that the apparent shift in the relationship
between vacancies and unemployment is neither unusual for a
recession nor likely to be persistent. Research has found
that during and immediately after the serious recessions of 1973
to 1975 and 1981 to 1982, the Beveridge curve also shifted
outward, but in both cases it shifted back inward during the
recovery. This temporary outward shift during a deep
recession may be the result of a particularly sharp increase in
layoffs, which raises unemployment quickly, even as vacancies
adjust more slowly. Another possible explanation for a
temporary shift in the Beveridge curve is extended and emergency
unemployment insurance, which induces unemployed workers who
might otherwise consider leaving the labor force to continue
searching for work. Or employers may be more selective in
hiring when their need for workers is not pressing and take more
time to fill vacancies in an effort to find especially qualified
hires. In any case, the data appear consistent with the
shift in the vacancy-unemployment relationship in recent years
having been relatively modest and likely to reverse, at least in
part, as the economy recovers further. When historical
experience is taken into account, these patterns do not support
the view that structural factors are a major cause of the
increase in unemployment during the most recent
recession.9

Conclusion
To sum up: A wide range of indicators suggests that the job
market has been improving, which is a welcome development
indeed. Still, conditions remain far from normal, as shown,
for example, by the high level of long-term unemployment and the
fact that jobs and hours worked remain well below pre-crisis
peaks, even without adjusting for growth in the labor
force. Moreover, we cannot yet be sure that the recent pace
of improvement in the labor market will be sustained.
Notably, an examination of recent deviations from Okun's law
suggests that the recent decline in the unemployment rate may
reflect, at least in part, a reversal of the unusually large
layoffs that occurred during late 2008 and over 2009. To
the extent that this reversal has been completed, further
significant improvements in the unemployment rate will likely
require a more-rapid expansion of production and demand from
consumers and businesses, a process that can be supported by
continued accommodative policies.

I also discussed long-term unemployment today, arguing that
cyclical rather than structural factors are likely the primary
source of its substantial increase during the recession. If
this assessment is correct, then accommodative policies to
support the economic recovery will help address this problem as
well. We must watch long-term unemployment especially
carefully, however. Even if the primary cause of high
long-term unemployment is insufficient aggregate demand, if
progress in reducing unemployment is too slow, the long-term
unemployed will see their skills and labor force attachment
atrophy further, possibly converting a cyclical problem into a
structural one.

If this hypothesis is wrong and structural factors are in fact
explaining much of the increase in long-term unemployment, then
the scope for countercyclical policies to address this problem
will be more limited. Even if that proves to be the case,
however, we should not conclude that nothing can be done.
If structural factors are the predominant explanation for the
increase in long-term unemployment, it will become even more
important to take the steps needed to ensure that workers are
able to obtain the skills needed to meet the demands of our
rapidly changing economy.

1. The broader measure of labor
underutilization referenced here is the U-5 measure of
unemployment, constructed by the Bureau of Labor
Statistics. Return
to text

7. For some discussion of this
effect, see Organisation for Economic Co-operation and
Development (2011), OECD
Employment Outlook 2011; and Aaronson and others, "What
Is behind the Rise in Long-Term Unemployment?" (see note
6). Return
to text

8. For an earlier analysis along
these lines, see Michael W. L. Elsby, Bart Hobijn, and Aysegül
Sahin (2010), "The Labor Market in the Great Recession,"
Brookings Papers on Economic Activity (Spring),
pp. 1-69. Return
to text

9. For a discussion of shifts in
the Beveridge curve during previous recessions, see John Lindner
and Murat Tasci (2010), "Has the Beveridge Curve Shifted?" Federal Reserve Bank of
Cleveland, Economic Trends, August; and Robert Valletta
and Katherine Kuang (2010), "Is Structural Unemployment on the Rise?"
Federal Reserve Bank of San
Francisco, FRBSF Economic Letter, 2010-34, November
8. For research examining the specific role of mismatch,
see Regis Barnichon and Andrew Figura (2010), "What Drives Movements in the Unemployment Rate? A
Decomposition of the Beveridge Curve (PDF)," Finance and
Economics Discussion Series 2010-48 (Washington: Board of
Governors of the Federal Reserve System, August); and Aysegül
Sahin, Joseph Song, Giorgio Topa, and Giovanni L. Violante
(2011), "Measuring Mismatch in the U.S. Labor Market,"
unpublished paper, Federal Reserve Bank of New York,
July. Other factors affecting the Beveridge curve include
the role of extended unemployment benefits and potential effects
of lags between vacancies and hiring; on the effects of
unemployment benefits, see Robert Valletta and Katherine Kuang
(2010), "Extended Unemployment and UI Benefits,"
Federal Reserve Bank of San Francisco,
FRBSF Economic Letter, 2010-12, April 19; on the lag
between job vacancies and hiring, see Steven J. Davis, R. Jason
Faberman, and John C. Haltiwanger (2010), "The
Establishment-Level Behavior of Vacancies and Hiring," NBER
Working Paper Series 16265 (Cambridge, Mass.: National
Bureau of Economic Research, August),
www.nber.org/papers/w16265. Return
to text